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The JOBS Act: Standardizing Crowdfunded Deal Terms

William Carleton, Contributing Editor, VCExperts


I typically stop reading articles that are negative about equity crowdfunding, sometimes after only a couple paragraphs, because they typically seem smug to me. Almost like the writer is assuring herself that she is part of some echelon of elites and that the crowds should be eating cake somewhere out of sight.

Not so this piece by Daniel Isenberg in the HBR Network. It's very negative - Isenberg even writes that "Crowds are frequently stupid" - but I don't think Isenberg is being superior and I do think his critique is healthy for crowdfunding advocates to grapple with.

One of the points in Isenberg's piece is that deal terms are too complex to be standardized.

"This investment process is just too complex to standardize in a way that would be understandable and useful for consumers, and still retain legitimacy. Many of the key concepts — such as implied valuation, liquidation preferences, minority protections, information rights, tagalong provisions, first refusal rights, anti-liquidation, reverse vesting, to name just a few — take years to grasp, let alone learn how to use. Furthermore, the final outcome of this alignment process (a signed term sheet and then definitive legal agreements) is frequently influenced by what areas of investment are considered hot at any given moment, and this can vary from month to month and even week to week, making standardization even more elusive."

Implicit in his critique is that crowdfunded deal terms simply must be standardized, if the equity crowdfunding is going to have a shot at being viable. He's right about that.

But whereas he sets up that implicit assumption in order to make the point that standardization is not acheivable, I happen to think deal terms could be standardized. Moreover, the portals or crowdfunding platforms will have an interest in doing so.

Ted Wang's Series Seed model is a good example of how an angel seed round financing can be standardized. That model could be adapted, simplified, for a crowdfunded deal. It may be that crowdfunded issuers should have a call right, at some multiple of the crowdfunders' original investment, to take take the crowdfunders out, clean up the cap table, and address the investor liquidity problem at the same time.

At any rate, it's imperative for the industry that deal terms not be negotiated, deal by deal. I think the successful crowdfunding platform or platforms, if there are to be such things, will have to standardize deal terms, ones that will tend to be entrepreneur friendly, to be sure, but that must provide some basic modicum of downside protection to the investors, and some preservation of upside, for the rare venture that does indeed succeed.

Image: a prototype kilogram, Wikimedia.

Valuation & Deal Term Data for Thousands of Private Company Financings

William Carleton

Bill is a member of McNaul Ebel Nawrot & Helgren PLLC, a Seattle law firm. He blogs every day at http://wac6.com.